5 reasons the dividend boom isn't about to go bust

The news keeps getting better for dividend investors. But can it last?

The latest sign of a dividend renaissance is Apple's decision to begin sharing some of its profits with shareholders for the first time in nearly two decades. The world's most valuable company will start paying a dividend later this year, rather than continue to stockpile cash from iPhone and iPad sales.

That announcement came a week after major banks moved to restore their dividends, after cutting them during the financial crisis to conserve cash. At least nine top banks plan to raise their payouts or are considering doing so after the government conducted stress tests to ensure the banks can survive another crisis.

It adds up to better times ahead for dividend investors. Payouts by companies in the Standard & Poor's 500 index are expected to climb 15 percent from last year to $277 billion, according to S&P Indices. That amount would top the previous record of $248 billion, set in 2008. Three-quarters of the S&P 500's dividend-paying companies are making higher payouts than they did last year.

Interest is so intense that hedge funds and many other Wall Street pros who normally avoid dividend stocks have been rushing into them lately, and Apple's actions can only add to the frenzy, says analyst Howard Silverblatt of S&P Indices.

In fact, dividend stocks have been among the market's strongest performers the past 12 months, a fact that hasn't been lost on investors. Over that period, they have deposited a net $25 billion into mutual funds specializing in dividend stocks _ usually labeled `equity income' funds _ according to industry consultant Strategic Insight.

That number wouldn't normally be impressive, except that the cash came in as investors pulled out of nearly all other types of stock funds. A net total of $136 billion was withdrawn from all other stock fund categories, reflecting investors' continuing fear of market volatility.

It's fueling talk that a dividend stock bubble might be developing. In one scenario, the economy hits another rough patch, companies conserve cash again by cutting dividends, and dividend stock share prices tumble.

It's dangerous to invest in a hot segment of the market, expecting the rally will continue _ just ask anyone who lost big in the dot-com era. But here are five reasons that dividend stocks are still sound investments.

1. Dividends are a long-term approach, not a trading strategy: The income that dividend stocks generate accounts for more than 40 percent of the total return of the S&P 500 since 1926, according to a study by Ibbotson Associates. The rest of the market's return came from rising stock prices. Companies can cut or eliminate dividends, as many did in 2009. But payouts usually are restored to their old levels in time. Dividends among S&P 500 companies are back to record levels now, thanks to the moves by banks and Apple.

2. Dividend-paying stocks are less volatile: Dividend-payers tend to rise more slowly during market rallies, but suffer smaller losses when stocks decline. So if a market downturn is around the corner, dividends will offer some protection. That's why they're so appealing to retirees, and any investor wanting to limit risk. "In the stock market, dividends are sort of the kids' end of the swimming pool. They're not too volatile for the average investor," says David Kelly, chief markets strategist at JPMorgan Funds.

3. Boomers will remain yield-hungry: Expect demographic trends to continue fueling demand for income-generating investments. Baby boomers are beginning to retire in large numbers. That trend is still young, and those retirees will need regular cash flow. Many will rely on dividends, creating demand that could help drive dividend stock prices higher.

4. Corporate cash is at record levels: Profits have risen so sharply the past couple years that the cash held by S&P 500 companies totaled a record $1 trillion in the fourth quarter. With such a big stash, the ratio of dividends being paid relative to cash on balance sheets remains historically low, Silverblatt says. That puts companies in good position to increase dividends, or follow Apple's example and initiate payouts. Last year, a record 22 companies initiated dividends, and Apple became the fourth to do so this year.

5. Dividends can survive possible tax hit: Since 2003, tax rates that investors pay on dividend income have topped out at a historically low 15 percent. President Obama's latest budget proposal would raise the rates on top earners to as high as 39.6 percent. That means the wealthiest could lose a quarter on every dollar of dividend income, compared with their tax hit under current rates. Yet it's hard to say whether Obama's proposal can clear Congress in an election year. Current rates are due to expire at year-end, unless Congress extends them.

Higher rates would make dividends less appealing to many investors, but wouldn't necessarily cause dividend stock prices to decline. A study this year by Nuveen Investments and Santa Barbara Asset Management found no link between past changes in dividend tax rates and dividend stock prices.

It all points to a dividend comeback that still has momentum. Says S&P's Silverblatt: "In the late 1990s, when tech stocks were the hottest thing, nobody wanted to touch dividend stocks. Now, people can't get enough of them, and it's not likely to let up soon."